Deck 10: Exchange Rates and Exchange Rate Systems

Question 1

If the forward rate is greater than the spot rate,what are markets signaling about their expectations for the future spot rates for the home currency?

Answer 1

The home currency is expected to depreciate over the maturity period of the forward contact.

Question 2

If the Costa Rican colone is expected to depreciate in the future,it will temporarily appreciate as people move to take advantage based on this expectation.

Answer 2

False

Question 3

In order to protect against foreign exchange risk,firms can use

A)the spot market for foreign exchange.
B)interest rate arbitrage.
C)the forward market for foreign exchange.
D)the J-curve.

Answer 3

C

Question 4

When an individual or firm in the United States requests that a bank sell foreign exchange,the bank will probably

A)call a foreign bank and arrange a purchase.
B)call the central bank and arrange a purchase.
C)call another bank customer with foreign exchange holdings.
D)call a foreign exchange broker and arrange a purchase.

Question 5

When Jeneva went to Costa Rica in July 2008,a U.S.dollar was worth 550 colones.If today a U.S.dollar is worth 650 colones,it means that the U.S.dollar has depreciated against the colone.

Question 6

Which currency is most commonly traded?

Question 7

The most important participants in foreign exchange markets are ________.

Question 8

What is the largest center for currency trading?

Question 9

Suppose that the U.S.Open ticket costs $100 and the British Open ticket costs £50 and the exchange rate is $1.43.How much does the British Open ticket cost for an American attending the British Open?

Question 10

Would each of the following groups be happy or unhappy if the Mexican peso appreciates against the U.S.dollar? Answer the question for each of the following:
(a) The U.S.pension funds holding Mexican government bonds
(b) U.S.tourists planning a trip to Mexico
(c) Mexican exporting manufacturers
(d) A Mexican firm trying to buy properties overseas

Question 11

Covered interest arbitrage involves both

A)the purchase of a foreign asset and a forward contract in the market for foreign exchange.
B)the purchase of a domestic asset and a spot contract in the market for foreign exchange.
C)the sale of a foreign asset and the purchase of a forward contract in the market for foreign exchange.
D)the sale of domestic stocks and the purchase of foreign bonds.

Question 12

A firm that buys foreign exchange in order to take advantage of higher foreign interest rates is

A)speculating.
B)demonstrating purchasing power parity.
C)engaging in interest rate arbitrage.
D)responding to fluctuations in the business cycle.

Question 13

The spot rate is the rate at which foreign currencies will be exchanged a specified number of days in the future.

Question 14

If Juana contracts to buy U.S.office equipment in U.S.dollars and her domestic currency depreciates against the U.S.dollar between the time the contract is signed and the bill is paid,she will wind up paying less for the equipment because she stayed in the spot market.

Question 15

A forward exchange market contract obligates the owner to make a trade at a specified exchange rate a fixed number of days in the future.

Question 16

How does the growth in the daily volume of foreign currency transactions compare with the growth rate of the global economy?

Question 17

Speculation would involve using forward contracts and options to reduce the exchange rate risk on future foreign exchange transactions.

Question 18

Suppose the dollar is subject to a floating exchange rate system and that R is the number of dollars per unit of foreign exchange.If R increases,then the dollar

A)depreciates.
B)appreciates.
C)is devalued.
D)is revalued.

Question 19

Which of the following institutions is the most important participant in foreign currency markets?

A)A retail customer
B)A commercial bank
C)A foreign exchange broker
D)A central bank

Question 20

Most currency trades in London do not involve the British pound.

Question 21

An American firm that buys foreign exchange because its managers expect the dollar to depreciate is

A)increasing the supply of foreign exchange.
B)decreasing the demand for foreign exchange.
C)speculating.
D)hedging.

Question 22

According to the text,which of the following factors may make the theory of purchasing power parity unrealistic?

A)Trading countries may stop exchanging goods once prices between them equalize.
B)Shipping, insurance, and transaction costs may reduce the implication of purchasing power parity.
C)Prices may not equalize if goods arbitrage is reduced by trade barriers.
D)The effects of purchasing power parity may not show up until many years have passed.

Question 23

The nominal interest rate in the U.S.is 5% and the nominal interest rate in Canada is 3%.The spot value of the U.S.dollar is 1 ($/Canadian dollar)and the forward rate is 1.2 ($/Canadian dollar).Which of the following is NOT true?

A)The dollar is likely to appreciate in spot markets.
B)The interest parity condition does not hold.
C)The dollar is trading at a forward discount.
D)Money will flow into the Canada.

Question 24

If the dollar/pound exchange rate is $2/£,a Big Mac costs $5 in New York City and costs £4 in London,the pound is ________,and U.S.tourists will be ________.

A)overvalued; better off in London
B)overvalued; better off in New York
C)undervalued; better off in London
D)undervalued; better off in New York

Question 25

In the short run,exchange rates are most directly affected by which of the following?

A)flows of financial capital
B)purchasing power parity
C)trade barriers
D)imports and exports

Question 26

If Mexicans increasingly lose confidence in their domestic financial markets and move their assets to other countries,the peso will depreciate.

Question 27

Suppose that there are only two countries,the U.S.and Japan.If real interest rates rise in Japan,which of the following is NOT true?

A)More Japanese yen will be supplied in exchange for dollars.
B)More U.S. dollars will be supplied in exchange for yen.
C)The volume of yen traded will increase.
D)Japanese borrowers will be worse off.

Question 28

If U.S.consumers increase their demand for foreign products and foreign travel,the U.S.dollar would tend to depreciate as more dollars are supplied to foreign exchange markets.

Question 29

All else equal,if Canada raises its interest rates,

A)the dollar depreciates.
B)the U.S. demand for Canadian dollars decreases.
C)the Canadian supply of Canadian dollars increases.
D)the Canadian dollar will depreciate.

Question 30

An increase in the U.S.demand for the Mexican peso

A)causes an increase in the U.S. dollar price of a Mexican peso.
B)causes the Mexican peso to appreciate.
C)causes the U.S. dollar to depreciate.
D)causes Mexican goods to be cheaper.

Question 31

All else equal and given the current system of exchange rates,if the United States enters a period of exceptionally strong growth,

A)the pressure on the dollar is to revalue.
B)the pressure on the dollar is to devalue.
C)the pressure on the dollar is to depreciate.
D)the pressure on the dollar is to appreciate.

Question 32

If the dollar/pound exchange rate is $2/£,a Big Mac costs $5 in New York City and costs £2 in London,the pound is ________,and U.S.tourists will be ________.

A)overvalued; better off in London
B)overvalued; better off in New York
C)undervalued; better off in London
D)undervalued; better off in New York

Question 33

A country that experiences higher real interest rates than other countries would expect its currency to depreciate.

Question 34

If inflation in the rest of the world is lower than inflation in Brazil,Brazil's currency (the real)would tend to appreciate.

Question 35

Which of the following would NOT be a cause for an increased American demand for the Mexican peso?

A)The United States having lower interest rates than Mexico
B)Increased American demand for Mexican goods
C)The expectation by speculators that the value of the peso is edging up
D)Greater economic growth in the United States

Question 36

Suppose the exchange rates between the United States and Canada are in long-run equilibrium as defined by the idea of purchasing power parity.If the law of one price holds perfectly,then differences between U.S.and Canadian rates of inflation would

A)have no effect on nominal exchange rates.
B)be completely offset by changes in the real exchange rate.
C)be completely offset by changes in the nominal exchange rate.
D)lead to a change in the real purchasing power of each country's currency when it is converted to the other country's currency.

Question 37

Which of the following is a FALSE statement concerning purchasing power parity?

A)Purchasing power parity states that dollars will tend to exchange for pounds at a rate that maintains a constant purchasing power of a given quantity of a currency.
B)It is rare to see deviations from the purchasing power parity value of currencies.
C)Over the long run, purchasing power parity exerts influence over exchange rates.
D)An overvalued dollar buys more in Britain than it does in the United States.

Question 38

A weak U.S.dollar leads to a higher volume of U.S.imports.

Question 39

Imports tend to fall whenever a nation's currency appreciates because foreign products become more expensive to domestic consumers.

Question 40

If more European and Japanese firms want to build factories and expand their offshore investments in the United States,the supply of U.S.dollars on foreign exchange markets will increase as a result of this investment activity.

Question 41

Which of the following defines a hard peg?

A)An exchange rate determined by the market
B)An exchange rate that fluctuates within a set band
C)An exchange rate that is not allowed to vary
D)An exchange rate that is backed by gold

Question 42

Which of the following defines a flexible exchange rate?

A)An exchange rate determined by the market
B)An exchange rate that fluctuates within a set band
C)An exchange rate that is not allowed to vary
D)An exchange rate that is backed by gold

Question 43

How does rapid economic growth at home affect foreign exchange markets?

Question 44

What matters most to importers and exporters is the nominal exchange rate.

Question 45

If nominal exchange rates do not change,an increase in the U.S.price level relative to the foreign price level represents a real appreciation of the dollar.However,if nominal exchange rates can change,is an increase in U.S.inflation relative to foreign inflation likely to cause appreciation of the dollar in the short run?

Question 46

The real exchange rate is defined as

A)the market exchange rate adjusted for price differences.
B)the purchasing power parity exchange rate.
C)the exchange rate that causes interest parity to hold.
D)the exchange rate that exists in major currency centers.

Question 47

A tourist going to Europe would be happy if the real exchange rate ($/€)increased.

Question 48

If inflation is higher in the home market,what is expected to happen to the real value of the home currency as time passes?

Question 49

Draw the demand for and supply of the U.S.dollar in each of the following cases.Diagram and explain in words the effect of each of the following events in the short run.Make sure to properly label the axes.In each case,assume the two countries under consideration are important trading partners.
(a) There is an increase in the real interest rates in the United States relative to Japan.
(b) Investment returns in the United States decrease relative to expected returns in Japan.
(c) Inflation in Japan fell relative to the inflation rate in the United States.
(d) The Japanese expect the value of the U.S.dollar to decline.
(e) The Federal Reserve raised interest rates fearing the inflationary pressures of a booming U.S.economy.

Question 50

According to purchasing power parity,which of the following is FALSE about an overvalued dollar compared to the Japanese yen?

A)U)S. merchants would be motivated to import more Japanese goods.
B)Japanese merchants would tend to export more to the United States.
C)Prices in the United States would tend to fall.
D)Over the long term, the exchange rate would fall.

Question 51

If the nominal exchange rate does not change,but U.S.prices rise,the real exchange rate has ________,and U.S.imports are likely to ________.

A)increased; rise
B)increased; fall
C)decreased; rise
D)decreased; fall

Question 52

The nominal interest rate in the U.S.is 5% and the nominal interest rate in Canada is 3%.The spot value of the U.S.dollar is 1 ($/Canadian dollar)and the forward rate is 1.2 ($/Canadian dollar).Calculate the forward discount or premium for the dollar.Does the interest parity condition hold? If not explain what is likely to occur in foreign exchange markets.Assume that interest rates cannot change.

Question 53

A rise in the real exchange rate represents an increase in the purchasing power of the home currency.

Question 54

When the purchasing power of currencies is the same,

A)interest parity holds.
B)currencies cannot change in value
C)the real exchange rate is equal to the nominal exchange rate.
D)interest rates are the same.

Question 55

Which of the following is true?

A)If an exchange rate is allowed to vary across a fixed basket of currencies, it is called a hard peg.
B)If an exchange rate is not allowed to vary against the target currency, it is called a soft peg.
C)If an exchange is only allowed to fluctuate within a set band, it is considered to be a flexible exchange rate system.
D)A soft peg is when a currency's exchange rate is only allowed to fluctuate within a set band.

Question 56

Holding nominal exchange rates constant,if inflation in Europe exceeds inflation in the United States,

A)the real exchange rate ($/€)will rise, and the euro will buy more in the U.S.
B)the real exchange rate ($/€)will rise, and the euro will buy less in the U.S.
C)the real exchange rate ($/€)will fall, and the euro will buy more in the U.S.
D)the real exchange rate ($/€)will fall, and the euro will buy less in the U.S.

Question 57

Suppose that the nominal exchange rate between the U.S.dollar and the Canadian dollar is 0.75 U.S.dollars per Canadian dollar.If Canada's rate of inflation is 0 percent and the U.S.rate is 10 percent,then the real exchange rate for the U.S.dollar will

A)appreciate by about 9 percent.
B)appreciate by 10 percent.
C)depreciate by about 9 percent.
D)depreciate by 10 percent.

Question 58

A rise in the nominal exchange rate ($/€)represents a depreciation of the dollar relative to the euro,but a rise in the real exchange rate ($/€)represent an appreciation of the dollar.Explain why this is true.

Question 59

If the Japanese central bank sells yen and buys U.S.dollars,the U.S.dollar will appreciate.

Question 60

Suppose that the nominal exchange rate between the U.S.dollar and the Mexican peso is 0.10 dollars per peso.If Mexico's inflation is 10 percent and the United States' inflation is 0 percent,from the U.S.point of view,the real exchange rate

A)appreciates to 0.11 dollars per peso.
B)depreciates to 0.11 dollars per peso.
C)appreciates to 0.09 dollars per peso.
D)depreciates to 0.09 dollars per peso.

Question 61

Economists usually favor a return to the gold standard.

Question 62

Soft pegs that are periodically adjusted are called

A)crawling pegs.
B)hard pegs.
C)snakes.
D)managed floats.

Question 63

The Bretton Woods exchange rate system was an example of a

A)managed float.
B)pure gold standard.
C)modified gold standard.
D)floating exchange rate system.

Question 64

Under a gold standard,countries should

A)keep the supply of their domestic money constant.
B)keep the supply of their domestic money fixed in proportion to their gold holdings.
C)keep the supply of foreign exchange less than their domestic money supply.
D)restrict the demand for foreign goods.

Question 65

When did major currencies begin floating against each other,ending the Bretton Woods system?

Question 66

Under a fixed exchange standard,if the domestic demand for foreign exchange increases,

A)the central monetary authority must meet the demand out of its reserves.
B)the central monetary authority must increase the supply of domestic money.
C)the fixed exchange standard will breakdown.
D)inflation will increase.

Question 67

What are the differences and similarities between a depreciation and devaluation of a currency?

Question 68

The majority of countries in the world have some type of fixed exchange rate system.

Question 69

Explain the three rules that countries must follow to maintain a gold standard.

Question 70

The traditional view of fixed rate systems was that

A)they improved inflation but were worse for growth.
B)they improved stability but were worse for inflation.
C)they improved inflation but worsened stability.
D)they improved growth but worsened inflation.

Question 71

A single currency area requires

A)mobile labor and synchronized business cycles.
B)immobile labor and synchronized business cycles.
C)immobile labor and mobile capital.
D)mobile labor and unsynchronized business cycles.

Question 72

Which of the following is NOT one of the determinants of the gains of adopting a single currency?

A)A well-synchronized business cycle involving all member countries
B)The possibility of factors of production to freely move across borders
C)The willingness and ability of member countries to design policies to address regional imbalances that may develop
D)Widening the common market by allowing other countries to join

Question 73

Explain the three rules that countries must follow to maintain a gold standard.

Question 74

Under a pure gold standard,

A)exchange rates float most of the time.
B)money is worth more than under other systems.
C)nations must buy and sell gold to settle international obligations.
D)there is no inflationary pressure.

Question 75

The biggest disadvantage of a fixed exchange rate is the

A)increased probability of high inflation.
B)tradeoff between supporting the exchange rate and adjusting the trade balance.
C)tradeoff between supporting the exchange rate and maintaining economic growth.
D)tradeoff between supporting the exchange rate and maintaining a balanced budget.

Question 76

The Smithsonian Agreement of 1971 was hailed by President Nixon as a fundamental reorganization of the international monetary system.In fact,what it accomplished was

A)the revaluation of the dollar.
B)the devaluation of the dollar.
C)an increase of the gold content of the dollar.
D)the elimination of gold backing for the dollar.

Question 77

If a currency has a fixed exchange rate,it is not subject to the forces of supply and demand.

Question 78

A reason why fixed exchange rate systems might lower growth is that

A)inflation may be higher.
B)monetary policy cannot be used.
C)they are more risky.
D)they deter international trade.

Question 79

Which of the following defines a soft peg?

A)An exchange rate determined by the market
B)An exchange rate that fluctuates within a set band
C)An exchange rate that is not allowed to vary
D)An exchange rate that is backed by gold

Question 80

Which of the following is not a true statement about the Bretton Woods system?

A)The value of the dollar was fixed in terms of gold.
B)Other currencies fixed values in terms of the dollar.
C)The U.S. was able to increase its money supply easily.
D)Trade deficits were eliminated.